OCIE Director Lists Issues that PE Firms Must Address
The SEC’s Director of Compliance, Inspections and Examinations, Carlo di Florio, recently outlined the conflicts of interest that newly-registered private equity fund advisers should address in their compliance programs. Mr. di Florio indicated that conflicts of interest should either be avoided or mitigated with “proper safeguards.” Mr di Florio said that in the fund-raising stage, PE firms should address: (i) disclosure of placement agent fees, (ii) fund recommendations by placement agents, (iii) side letters that favor certain clients, (iv) marketing materials that make misleading performance comparisons, and (v) oversizing the fund relative to the firm’s ability to deploy capital. At the investment stage, firms should monitor: (i) insider trading that could arise from involvement with portfolio companies, (ii) allocation of investment opportunities especially to co-investment vehicles, (iii) investment in a portfolio company as both an equity investor and bondholder, and (iv) transaction fees charged to portfolio companies. During the management stage, PE firms must consider: (i) valuation of portfolio companies for performance reporting or marketing, (ii) marketing materials that highlight successful investments, and (iii) fees charged to portfolio companies. Firms should also consider the impact of liquidity events on different funds and the effect on the firm’s fees. Mr. di Florio stressed the importance of a strong compliance officer and program to monitor and address conflicts of interest, as required by Rule 206(4)-7.
OUR TAKE: Mr. di Florio is giving PE firms a roadmap for building their compliance programs, which OCIE will test during exams. Failure to address this long list of issues will result in deficiency letters (which clients often request) and referrals to the Division of Enforcement.